If you are a US shareholder of your business, but the other non-US owners own the majority of the
company, it may not be a CFC. Instead, you need to look at the Passive Foreign Investment Company or PFIC rules.
The PFIC rules recognise that you do not have control over the non-US company. A PFIC could be anything from a company where you and other Americans own up to 50% but do not have control in a private business, or where you own one stock in a non-US investment that you have made.
Broadly a PFIC is a non-US company which meets either of the following:
- Income Test: at least 75% of the company’s gross income is passive income
- Asset Test: at least 50% of the company’s gross assets are passive assets
For entrepreneurs, most of the time, the company will initially be an active trade and not necessarily a PFIC. However, as circumstances change so might the status as a PFIC. For example, if investments are realised by the company or the value of some passive assets increases. PFIC status needs to be monitored because Once a PFIC, always a PFIC.
In particular, this can be an issue for companies with large amounts of retained earnings, or where they may have accepted assets, such as shares or cryptocurrency, during the course of its business.
The reason PFICs are bad for US tax is that on the sale of the shares, rather than qualifying for long-term capital gains tax in the US at 20%, instead you will be taxed at the ordinary income tax rate. In addition, there is also an interest charge which relates to the period that you have owned the PFIC.
Therefore, if a company was owned for five years, where the PFIC test was met, the IRS considers the gain made to be spread over those five years and any tax associated with that gain has a compounded interest charge put on it. For longer holding periods, it can result in taxation of up to 100% in extreme circumstances. Clearly this is incredibly inefficient for tax. Therefore, it is important that advice is sought from ahead of any investment to ascertain whether it is a PFIC or if a private investment which is not a PFIC currently, that this status is monitored as it is important that this does not occur.